Office Sector Fundamentals: Concessions Impact Rent Growth
In recent years, the office sector has been defined by familiar trends such as a flight to quality, rising vacancies, and falling rents. According to a new report from CBRE analysts, record-high concessions have played a significant role in influencing base rents.
Understanding Base Rents
Base rents or asking rents refer to the initial rent for the first year of a lease term. CBRE analysts note that top-tier buildings (Class A and above) have seen an increase of 2.6% in base rent since 2022 while Class B and C buildings have experienced an average decrease of 1%. While these numbers may not be cause for celebration or concern on their own, they only tell part of the story.
The Importance of Incentives
When discussing any type of rent, it is crucial to consider incentives or concessions that landlords offer tenants as enticements. As current market conditions favor occupiers over landlords, it is no surprise that concessions are being used more frequently by landlords looking to attract tenants.
CBRE’s report highlights how effective rents have decreased since 2022 due largely in part to “record-high landlord concessions.” Effective rent for top-tier properties has dropped by 1.2%, while lower-tier assets saw an even greater decline at -3.9%.
Tenant Improvements Play A Role
Landlords across both high- and low-end office spaces increased tenant improvement allowances between Q3 2020 through Q3
of this year with TI allowances increasing by up tp $98 per square foot for top-tier properties compared with $85 per square foot among lower tier assets during this period.
Interestingly enough though there was still growth when comparing these numbers against those from before COVID-19 hit back in late February/early March last year where we saw increases around +37% higher than what we’re seeing today which could suggest some level uncertainty for landlords in terms of what tenants want and need today.
The 2024 Forecast
CBRE analysts predict that asking rents could decrease by 3-4% in the coming year, with a potential moderation of concessions as well. As financing costs rise and access to funding becomes more limited, landlords will have to find other ways to appeal to tenants without relying on concessions.
Some strategies may include offering shared building services, flexible space options, or expansion/contraction opportunities. The demand for top-tier properties is expected to remain strong as occupiers continue seeking high-quality spaces in desirable submarkets.
In conclusion, while record-high concessions have had an impact on effective rent growth over the past few years, there are signs that this trend may start moderating moving forward as market conditions evolve.
